Fit for merger?

The CM140921-gymA’s long-awaited lengthy merger decision on the Pure Gym/The Gym deal has finally been published, nearly two and a half months after the decision was announced to refer it for Phase 2 investigation.

Although the deal was abandoned soon after the reference decision was made, the decision itself is one of the most interesting decisions of the year.

In terms of some of the issues raised, it reminds me very much of the OFT’s Rank/Gala casinos decision almost exactly two years ago.

It should give plenty of food for thought to merging parties in similar types of business on matters such as:

  • how important national parameters of competition can be, even when services are provided through local outlets
  • the importance of realistically assessing which types of outlet compete most strongly and how – not all gyms are created equal, it appears
  • why 80% customer catchment areas are not always the whole story in thinking about the geographic scope of competition
  • how internal documents need to provide sufficient support to the narrative parties put forward
  • why potential competition between parties (i.e. in opening new outlets near the other party) can be every bit as important as existing overlaps, especially where there is only a small number of national players
  • the role of entry analysis and customer switching analysis when competition is as much about fighting for new customers as it is about retaining existing customers and when tariff structures complicate incentives
  • what can happen when the CMA believes it may not have received all the information that is available
  • why website material can become an important source of evidence that needs to be managed well
  • the importance the CMA can attach to being able to replicate or extend results of analysis that the parties present.

Throughout the decision the CMA makes repeated reference to the commentary on retail mergers, published jointly by the former OFT and CC .

It is well worth reading and fully considering the points made in the commentary if you are contemplating a retail merger (even though I would say that having had a close hand in developing the retail commentary!).

The commentary can be found here and the decision itself is here.

 

Recent UK merger control: from soft drinks to hard cheese

UK merger control over the past year – and looking ahead

On April 1st the Competition and Markets Authority (CMA) took over UK merger control responsibilities from the Office of Fair Trading and Competition Commission.

In this article I

  • take a high-level look at trends in UK Phase 1 and Phase 2 merger cases in the final year leading up to the new CMA
  • note some developments in assessment methods
  • set out in brief a few of the lessons that future merging parties may want to consider from the past year’s cases – and
  • look ahead to how the changes in the regime might affect future analysis.

Phase 1

The following chart compares the year to the end of March 2014 with the average across all cases in previous years under the Enterprise Act.

The figures focus on those cases that the OFT decided to qualify for assessment under the jurisdictional tests – hence the term ‘qualified cases’.

140508-Oft-stats-13-14

The key points are as follows:

  • Case numbers have been significantly down on previous years
  • The proportion of ‘substantial lessening of competition’ (SLC) findings was in line with previous years
  • No undertakings-in-lieu of reference were accepted, the first time this has happened (though with one remedy still outstanding)
  • Use of the de minimis discretion was in line with past averages
  • There has been much greater use of initial ‘hold separate’ undertakings, something that looks set to continue under the CMA.

The signs are that the low case numbers have continued (though activity seems now to be increasing):

  • Only 19 Phase 1 decisions up to May 1st this year

…. 50% down on the same point last year.

This should come as no surprise. Merger decisions occur with a time-lag and….

  • There were just 99 domestic and cross border transactions involving UK companies (excluding outward disposals) in the final quarter of 2013…

… the lowest number since quarterly figures were first collected in 1987.

  • For 2013 as a whole such deals were down 50% on 2011 (450, compared to 965).

As in previous years, the number of competitors and low increment to share of supply have been the most important factors in clearance decisions. Buyer power and entry arguments were important, however, in a small number of cases.

Phase 2

Of the references to Phase 2 made in the year up to 31st March to date there have been

  • 4 clearances (including a dissenting opinion in one case)
  • 2 SLC decisions involving remedies – one of them a price cap remedy (a pretty rare animal in the UK these days!)
  • and 2 other decisions are awaited.

Assessment methods – some points of interest

Before looking at some of the lessons for future merging parties I note here a few of the points of interest across the year in terms of the analytical approaches and techniques used by the merger authorities. These include:

  • A customer survey containing both a price rise question and a store closure question, enabling direct comparison of results as to how customers respond to each. This is often a bone of contention in cases where only the store closure question is asked and it is assumed that the answers carry across to consumer behaviour in response to price changes. There is only a handful of UK cases in which both questions have been asked.
  • Use of ‘uplifts’ to create ‘extended’ catchment areas, much larger than the often-used ‘80%’ catchment areas. These extended catchments can increase the number of overlaps between parties but, at the same time, can bring additional competitors into the analysis
  • Use of concentration ‘hotspot analysis’ to pick up concerns relating to particular areas/groups of customers within a catchment
  • Development of GP referral analysis methods, including analysis focused on the GPs most likely to switch referral hospitals.

More generally, there has been relatively little use of price pressure analyses this year and merger simulation has been rarely used.

By contrast, many cases have involved the use of ‘catchment area’ analysis and  analysis of internal documents has been important to a number of decisions.

It is worth noting that the new (much-enlarged) CMA notification form for Phase 1 has expanded the set of internal documents that are requested upfront.

Lessons for future merging parties

Within the scope of this article it is only possible to give a brief overview but below I set out some of the lessons for future merging parties drawn from published material on  Phase 1 and Phase 2 cases over the past year.

Many of the lessons have implications for pre-merger planning, both in terms of:

  1. assessing the risk of a deal being referred to Phase 2 and
  2. planning ahead so that the strongest case can be put within the Phase 1 timetable (which is changing under the CMA).

Here are some of the most notable points arising from the 2013/14 cases:

  • Be aware of the dangers of over-estimating rivals’ shares of supply – but try not to underestimate them either, as happened in one case.

– Large discrepancies between the parties’ figures and those obtained by the authorities in their enquiries of customers and competitors can undermine confidence in other material the parties put forward

  • Remember that the set of companies judged to be competitors can differ from case to case, even in sectors that have been examined previously….and many times over.

– This is important in pre-merger planning, in assessing the risks of a merger being referred to Phase 2 and the risk of it being found to be problematic at Phase 2.

  • Bidding data and data on sales won and lost were used across a large number of cases, more frequently than in previous years (though this may be due to the mix of cases rather than an underlying shift in approach).

– Bid data can be time-consuming to assemble so that it is sufficiently comprehensive. Early planning and gathering of material is therefore important.

  • Bear in mind capacity constraints that rivals may have, an important consideration in one of the 2013 references

– It is particularly important to distinguish between ‘theoretical capacity’ (which may be very large but may be costly to deploy in full) and that capacity that it may be realistic and economic to bring on stream.

  • Modelling of the merger impact on comparative tendering costs among rivals can be very powerful, as one clearance case this year showed.

– In some markets the key constraint on prices is the bidder who comes second. The key question is therefore what the merger does – if anything – to that player’s bid.

  • Once again this year, several cases have shown how important it is for parties to engage with the competition authorities if they are planning their own consumer survey work.

– This will become even more important looking ahead given the new merger timetables.

  • Ensure that in comparing branded and private label products – and the extent to which they compete – that the effect of price promotions is properly considered.

– For example, how close might be the price of branded goods that are heavily promoted to the price of private label products that are not?

  • Past failures can be very helpful !… especially if they relate to past attempts by one of the merging parties to enter a market against the other party.

– This helped dampen concerns about the potential for the parties to compete in one case this year.

  • Though on average they raise the probability of a case being seen to be problematic, customer complaints are not of themselves a good predictor of the outcome of a case

– For example, one notable case was cleared this year despite most customers complaining about it. Equally, many cases have been referred to Phase 2 in previous years without there being significant levels of complaint.

  • They may be rare, but successful efficiency arguments are possible when there are real synergies, backed with the right analysis

– as shown in a ‘3 to 2’ merger where plant location and logistics opened up new opportunities for the merged firm to reduce its costs – opportunities that would not otherwise have been possible.

  • Post-merger price increases – projected or actual (in the case of completed mergers) – often cause difficulties but sometimes evidence can be successfully put forward to justify even very large post-merger price increases

– as happened in one completed merger case this year – in which the increases were judged to be investments in quality

  • There appears to be continuing development in the use of ‘de minimis’ policy (i.e. policy that avoids referring to Phase 2 cases that raise significant competition concerns but are thought to be too small to merit further investigation)

– especially in exercising the discretion not to refer cases to Phase 2 in sectors in which similar deals are possible (perhaps even likely) in other local areas.

Looking ahead

Although much will stay the same, the arrival of the CMA brings a number of changes to UK merger control the effects of which will not be clear for some time.

The main changes being made include:

  • New hold-separate powers
  • Much more extensive Phase 1 notification forms
  • The new 40-day statutory timetable for Phase 1 mergers
  • New information-gathering powers
  • Some overlap between the Phase 1 and Phase 2 case teams
  • A new remedies process at Phase 1
  • Access to the Phase 1 decision-maker for merger parties

For the area that I am most often involved in – merger evidence-gathering and analysis – there are many questions that the next year will start to answer, including the following:

  • What will happen to the overall Phase 1 timetable given the need for more pre-notification discussions?
  • To what extent will the changes delay third party enquiries in terms of their place within the overall process? And what effect will any delay have on the risk of new questions emerging late on and the number of cases going to Phase 2?
  • What in turn will the implications be of any change in these areas for the quality of analysis and for decision-making thresholds?
  • To what extent will the new information-gathering powers blur the distinction between Phase 1 and Phase 2 and affect the decision-making thresholds?

And that is to say nothing of the more process-based questions on matters such as ‘stopping the clock’ and remedies where the devil really will be in the detail.

It may take a considerable time for the implications of the changes to become clear, particularly any unintended consequences.

Case circumstances vary considerably so that making judgements on what the changes may mean over, say, the first 10 cases – or even the first 20 – could prove as unreliable as making judgements on SLC trends from a similarly short run of cases (a topic I hope to return to in a future article).

Much more on all this in future merger workshops….

 

© Adrian Payne 2014

 

 

 

 

One Question That Can Make Or Break A Merger Case

Over the past ten years hundreds of companies have made a case to the UK competition authorities seeking approval for their merger.

The way in which cases are argued and presented before the authorities varies widely. As a result, there are many lessons that can be learned from past practice, good and bad.

In this brief article I focus on one important aspect that crops up again and again. It concerns the following question:

–       How to make a case that fits together well?    –

A question to ask early

It is clearly a question that is best asked (and answered) early on in the process of developing the case for a merger.

Rubik

And yet, in the hurly burly of the deal, it is a question that is easy to overlook –  or to ask too late in the process – or to answer only partially.

Instead what tends to happen in these circumstances is that the different elements of the case emerge and evolve as the process unfolds.

Such an approach may have the advantage of flexibility  – but it also carries the risk that, once the walls are built, the roof won’t fit.

And that is indeed what happens in a surprising number of cases, resulting in

  • Wasted time and cost
  • A longer investigation –  and – in some cases
  • A poorer overall outcome for the merging parties.

A challenging question

Perhaps one of the reasons the question doesn’t always receive the timely attention it deserves is that there are a number of different aspects to it.

Here are the five I look at:

1. Are the arguments put forward internally consistent ?

  • When the individual building blocks of a case do not hang together well the credibility of the overall case suffers and the process takes longer, while inconsistencies are probed.
  • To take a simple example that has arisen many times: how well does the argument that acquisition is the only path sit with the proposition that entry into the business is easy and inexpensive?

2. How to ensure the case put forward remains consistent throughout the process ?

  • Changing tack on a major plank of a case during the process always raises questions in the agencies’ minds.
  • ‘Why”, they understandably ask, “should the new story we are being told be more credible than the old one (which we were assured was accurate)?”

3. How well is the overall story for the merger supported by the evidence advanced?

  • When these clash the agencies rightly question not only the particular piece of evidence concerned but – sometimes more damaging –  the coherence of the wider story.
  • For example: If the overarching story is that exit of the target company is inevitable in the absence of the deal, how well does this tally with the actions of the target in the past year or two?

4. Do the theory and evidence match?

  • When theory and evidence collide which, if either, will remain standing?
  • For example: where a case relies heavily on the theory that only two suppliers are needed to ensure a highly competitive outcome, how credible is that theory given the number of suppliers that customers actually shortlist?

5. How well integrated are the business, economic and legal arguments?

  • A particular risk is where separate submissions from legal advisers and economic advisers contain material that does not fit together well (or at worst is contradictory).
  • Another is when key analysis is identified and put forward too late in the day.

A powerful first step

The very process of asking each of these questions in a structured way, and with the right tools and techniques, is a powerful first step to:

  • understanding the real strength or weakness of the case right from the start
  • prioritising the evidence-gathering and analysis needed to make the strongest case
  • deciding how best to present the case
  • managing the five risks/opportunities I outlined above.

Even where it turns out that there is not an immediate or clear answer to one or more of these questions, identifying that fact can be crucial to managing the resulting risk, as well as the overall case.

                                                                                               © Adrian Payne 2013

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Material in this article is drawn from my training course – ‘Making a Merger Case: Best Practice and Common Pitfalls’.

The course examines lessons from over 500 past cases in each of the following areas: case preparation, case strategy, research and analysis, communication and presentation, and resources.